The US economy is at a critical juncture, with Donald Trump's attempts to influence the Federal Reserve potentially triggering a 1970s-style inflationary spiral and a global financial backlash. This scenario is a stark reminder of the delicate balance between political pressure and central bank independence, and the potential consequences for the world economy. But here's where it gets controversial...
After the US Department of Justice launched a criminal investigation into Jerome Powell, the current Fed chair, investors expressed concern that the White House's efforts to pressure the central bank to cut interest rates could put the global economy at risk. This has led to a surge in safe-haven assets, with the US dollar falling and gold prices hitting a record high.
The parallels with the 1970s are striking. Then, US inflation soared after President Richard Nixon pressured the Fed to ease monetary policy to help his 1972 election campaign. This led to a period of high inflation and economic instability, with the Fed ultimately having to raise interest rates to restore price stability.
Atakan Bakiskan, a US economist at Berenberg bank, warns that if the Fed pursues an ultra-accommodative monetary policy despite higher inflation, the result could resemble the 1970s in a worst-case risk scenario. He also notes that if the Fed acts on politics rather than data, foreign investors could pull back on financing the US debt and seek new safe havens.
The current situation is further complicated by the fact that the US inflation rate has fallen back from a peak of over 9% in 2022, but the headline rate picked up to 3% in September. This has allowed the Fed to cut borrowing costs, but the risk of a return to high inflation remains.
Jagjit Chadha, a professor of economics at Cambridge University and former director of the National Institute of Economic and Social Research, warns that if interest rates are reduced too quickly, there is a real danger that inflation will jump out of control again, damaging people on low incomes. He also notes the implications for the rest of the world, particularly in terms of the dollar's role as a global reserve currency.
The controversy surrounding Trump's attempts to influence the Fed is further heightened by the fact that no Fed chair has ever been fired by a president. Trump has repeatedly attacked Powell for refusing to cut borrowing costs more aggressively, and has threatened legal action over the Fed's renovation project. However, on Sunday, he denied any involvement in the DoJ investigation.
This is a dangerous moment for the US economy and the world. As Jason Furman, a Harvard economist who was chair of Barack Obama's council of economic advisers, notes, some countries have prosecuted or threatened to prosecute central bankers for the purpose of political intimidation or punishment for monetary policy decisions. This is a stark reminder of the importance of central bank independence and the potential consequences of political interference.
